The Lonza Group ( OTCPK:LZAGY) ( OTCPK:LZAGF) is a chemical and biotechnology company supplying high quality ingredients to the pharmaceutical industry where it has established and maintained long-term customer relationships. That’s great, but it also means that stocks are trading at fairly high multiples (not uncommon for Swiss companies). Lonza has a very strong balance sheet and has provided an attractive longer-term outlook, but the main question is whether or not the recent share price decline is an opportunity to buy the stock.
Lonza is a Swiss company and has its primary listing in Switzerland where it trades with LONN as its ticker symbol. The average daily volume in Switzerland is approximately 160,000 shares per day. The current market capitalization is slightly above CHF 46 billion after the recent correction where Lonza hit all-time highs. I will use the Swiss franc [CHF] as the base currency throughout this article.
The annual results are now known and they are encouraging
In 2021, Lonza saw its revenue increase by around 20%, but unfortunately COGS increased at a faster rate, which meant that the increase in gross margin was rather limited to just under 15% . This is obviously still a good performance, but the gross margin of 39% in 2021 is clearly worse than the 41% in 2020. Also, as you can see below, Lonza actually recorded a lower EBIT compared to to 2020 despite higher revenues than operating expenses increased by about a third.
However, there is nothing to fear. 2021 operating expenses included a negative impact of CHF 300m on a non-recurring item, meaning that on an underlying basis we would likely have seen net profit well above the CHF 800m mark . You also see that the reported net income is approximately CHF 2.95 billion, but that includes the one-time gain from the sale of the Specialty Ingredients business. So while the net profit of CHF 2.95 billion cannot be compared to the CHF 732 million of FY2020, neither can the net profit of CHF 677 million from continuing operations.
The company will pay a dividend of CHF 3/share, which represents a dividend yield of less than 0.5%. The Swiss withholding tax rate on dividends is 35% and that’s quite high. Fortunately, Lonza has determined that half of the dividend will be taken from the capital contribution reserve and that these payments are not subject to Swiss withholding tax. This means that there will be an average withholding tax rate on dividends of 17.5% (35% on 50% of the distribution), which is more acceptable.
Converting 2024 targets into numbers
Lonza has reconfirmed its guidance for 2024 and now that we have the final results for 2021 we can start working on an EBITDA expectation for 2024. First, here are the guidance:
Lonza has also been kind enough to break down the 2021 results into its base revenue, while providing base EBITDA in 2021, where we see the base EBITDA margin was approximately 30.8%. This is interesting because it means that Lonza is aiming for a higher margin on higher income.
We can now use the turnover of CHF 5.4 billion in 2021 as a starting point. If I use an average annual turnover increase of 11.5% by 2024, we should be able to expect a turnover of CHF 7.5 billion in 2024. Applying a EBITDA margin of 33% would then translate to an EBITDA of approximately CHF 2.5 billion, which is approximately 50% higher than the base EBITDA generated in 2021.
Revenue growth will come from self-funded growth projects. Lonza has approximately CHF 800 million of net cash and its low dividend should allow the company to finance its investment program without having to raise funds.
The image above is actually very interesting because it shows that maintenance investments are only 20% of the total budget. With an annual capex budget of 1 to 1.2 billion Swiss francs, the maintenance capex is really only a few hundred million dollars per year.
This means that if I applied CHF 800 million of depreciation (CHF 514 million for FY2021) on the CHF 2.5 billion EBITDA in 2024 while also applying an average tax rate of 18 %, this should yield net income of CHF 1.4 billion and maintain free cash flow of CHF 1.9 billion, or approximately CHF 26 per share (assuming the number of shares remains unchanged).
It is good to see Lonza confirming its guidance for 2024 and now that the 2021 results have been released it is also easier to understand the implications of the 2022-2024 growth forecast. Lonza is in a great position as it should be able to self-fund its growth plans, but unfortunately that doesn’t mean the company is cheap as it is already trading at a multiple of around 25 times its cash flow. available from 2024.
The EV/EBITDA ratio seems to be better thanks to Lonza’s strong net cash position, but an EV/EBITDA ratio of around 18 is also not attractive enough for me to go to Lonza, despite the recent drop in 15% of the share price.
The question then is at what price level would I feel comfortable initiating a long position. If Lonza is indeed able to achieve its goals, I think the lower 500 range would be more interesting. So rather than buying the stock outright, I might consider writing a long-term put. A P520 expiring in June 2023, for example, has an option premium of almost CHF40, which would mean I would buy the stock at CHF480 – if the put expires in the money. And if Lonza’s stock price stays strong, I can just keep the option premium as compensation for my time and effort.